By Columbia – Lexington Bankruptcy Attorney Lex Rogerson
In 1983, the Supreme Court decided creditors who seize or repossess property may have to return it when the debtor files bankruptcy.
In the first of a series on high court precedents favoring debtors, we look at the 1983 decision in United States v. Whiting Pools, Inc. There the Court decided that the Code protects the debtor’s property even if it has already been taken by a creditor. Although the case involved a New York chapter 11 business reorganization, the rule it established has turned out to benefit Columbia area consumers facing repossession as well, allowing them to recover their property through chapter 13.
How the decision came about
The Whiting company operated a business selling and servicing swimming pools near Rochester, NY. Because it failed to remit some $90,000 in withholding taxes on its employees, the IRS filed a tax lien and seized virtually all the company’s inventory and equipment, intending to sell it and recover the past due taxes. Before the sale, however, Whiting Pools filed a chapter 11 bankruptcy case to reorganize its debt and remain in business. The IRS then moved for permission to complete the sale.
In response, Whiting asked the court to order the IRS to turn over the seized property, claiming the goods were necessary to its reorganization effort. The court sided with Whiting and required the IRS to return the property. After two rounds of appeals in which each side won once, the U.S. Supreme Court agreed to decide the case.
Under section 541 of the Bankruptcy Code, the filing of a bankruptcy case creates an estate composed of all property in which the debtor has any substantial ownership interest. This is much like a probate estate that comes into existence when a person dies. Property of the estate is protected from creditors by an automatic stay that prevents them from controlling or disposing of the property. And entities in possession of estate property are required to turn it over to the debtor or the bankruptcy trustee if the property is necessary for an effective reorganization.
The Supreme Court decided these provisions mean a creditor who has seized property before filing but has not yet sold the property must usually return it, because the debtor continues to have an ownership interest even if it no longer has possession. In this regard, the IRS is like any other creditor. So Whiting Pools got back its inventory and equipment, was able to continue in business, and reorganized successfully, paying the IRS in the process.
What it means for consumers
If a company’s life blood is its inventory and equipment, the most important asset for most individuals to remain productive is a car or truck. The decision in Whiting Pools has been important for consumers whose vehicles are repossessed, or threatened with repossession, in the days leading up to filing bankruptcy. In 1989, the bankruptcy court for the District of South Carolina extended the right of turnover to consumers, requiring an auto finance company to return Debtor Sheila Matthews’ car, which it had repossessed nine days before she filed her chapter 13 case. Our court has further held a creditor cannot withhold possession until the debtor obtains a turnover order from the court but must instead return the car as soon as the debtor demands possession and proves insurance coverage. In addition, when bankruptcy is imminent, auto lenders can sometimes be persuaded not to repossess by pointing out they will simply have to return the vehicle as soon as the debtor files.
The right to turnover is not unlimited. First, it is usually only useful in chapter 13, as chapter 7 provides little help in reorganizing secured debts. Second, in order for the property to be protected as property of the bankruptcy estate, the debtor must have had some meaningful ownership rights when the bankruptcy case was filed. Under the Uniform Commercial Code, the owner of a car or other item that has been repossessed has a right of redemption until the creditor has sold or disposed of it. If the collateral is sold before the bankruptcy filing, it is too late to save it.
The narrow window of time between a repossession and the sale of the collateral means timing is critical. If you are considering bankruptcy and repossession is on the horizon, it is critical to move without delay.